Questions to ask about offshore investment

Investing offshore can be a good wealth-enhancement strategy. If you belong to a pension fund, your funds are likely invested in some non-South African assets, giving you exposure to global markets.

This article unpacks reasons for investing offshore, and questions to ask a portfolio manager before you take the leap.

Tip: Investing in unit trusts can help you to beat inflation and boost your retirement savings. Find out more here.

The benefits of offshore exposure

It pays to be exposed to global markets as you seek to grow your investments.

It’s possible for up to 45% of your retirement funds to be invested in non-South African assets. This includes a 10% allowance for investments in other African countries. Regulation 28 of the pension funds act governs these allowances.

“Regulation 28 has the good intention of protecting people’s retirement savings from too great an exposure to some asset classes,” says Kyle Wales, global portfolio asset manager at Flagship Asset Management.

“However, the limitations are also a form of stealthy exchange control, keeping funds within the country. In the United Kingdom, for example, asset managers have total control over where to invest pension fund monies.”

The previous limit was set at 30% for investment in non-South African assets, so the new limit exposes investors to a wider range of investment opportunities.

Although there is a risk that comes with exposure to global markets - no market is immune to a financial downturn or crisis - investing in South Africa means you are exposed to less than a 1% share of global growth.

Wales says South Africans are restricted to investing in a smaller basket of companies than the thousands of options available to those who invest overseas.

“While the Johannesburg Stock Exchange (JSE) has shown strong financial performance, over time it is generally outperformed by some of the world’s major stock market indexes,” he says.

However, you can invest indirectly in offshore markets, via the JSE Top 40. Many of these companies derive a percentage of their profits from international markets, says Munaf Mukadam, a financial adviser at Gradidge-Mahura Investments.

Tax advantages

Mukadam says there are tax advantages to offshore investment that are worth considering.

“With an offshore investment, you are literally converting your rands into dollars and investing them in worldwide assets. You will therefore only pay capital gains tax on the investment growth.

“If the rand depreciates over the investment term, your dollars will be worth more rands. However, these higher returns, based on the rand’s depreciation, will not attract capital gains tax.”

In contrast, if you invest, for example, in an offshore feeder fund, which does not convert your rands into foreign currency, you will pay capital gains tax on both investment performance and any exchange-based increase to your returns in rands.

“If the fund achieves a 10% return and the rand has depreciated by 10%, you will pay tax on the total return of 20%,” he explains.

Questions to ask your portfolio manager

If you are planning to invest offshore, you should ask your portfolio manager about asset class allocation, section allocation and geographical allocation, says Mukadam.

“Your portfolio manager may tell you that your funds are invested ‘offshore’, but what does this mean? Which countries are your funds invested in, and which currencies and assets are they being exposed to?”

Asset allocation is also important. You want to be invested in a wide range of assets that are not closely linked, and do not respond in the same way to market movements.

“It’s risky if you are invested, for example, in three equity funds that are mostly invested in technology,” says Mukadam. Sector diversification helps to spread the risk around.

“While an investment portfolio should be diversified, the asset allocation should be centred around your objectives, your appetite for risk, and the length of the investment period.”

You should also ask your portfolio manager about costs. These are typically made up of advice fees, administration fees, and asset management fees.

“Advice fees should be the same if you’re invested locally or offshore, but if your total fee is more than roughly 2.5%, you may be paying too much,” says Mukadam.

“Do remember, though, that you can’t look at fees alone – you should also consider performance and returns. For example, certain hedge fund fees can reach 3% or more because of performance fees. However, if they perform better than the overall market, and are providing investors with market-beating returns, then you could argue that those fees are justified.”

Finally, ask your portfolio manager what would happen to your investments if you were to pass away - especially as regards your offshore assets.

“You don’t normally select beneficiaries if you hold unit trusts, for example, so the funds form part of your estate. It’s therefore up to your executor to bring them back into South Africa and calculate the tax,” Mukadam explains. This can cause administrative delays in winding up an estate.

“Alternatively, if you are invested in an offshore endowment, you are able to select a beneficiary, and your monies will be forwarded to that individual directly from the investment company,” he concludes.

Tip: Start saving for your retirement today by investing in an annuity. Read more here.